EU lawmakers have pushed back a vote on the controversial directive on Alternative Investment Fund Managers (AIFM) until October. The directive touches on most aspects of the hedge fund industry: remuneration, depositories and, perhaps most controversially, third-country funds (the more conservative EU Parliamentary version of the directive would make it very difficult for managers based outside the EU to market their funds in the union). Andrew Baker, CEO of the Alternative Investment Management Association (AIMA), a global hedge fund trade association with over 1,100 members, thinks the delay is a good thing. FINalternatives' Mary Campbell spoke with him recently about AIMA’s concerns about the directive, worst case scenarios and why, ultimately, he’s optimistic about the final outcome for Europe’s hedge fund industry.

The latest news out of Brussels is that, although the vote on the AIFM directive has been postponed again, negotiators may have reached a compromise on the sticky issue of abolishing private placement regimes. What have you heard in this regard?

We understand that a possible compromise on the third-country issue could allow the continuation of passive marketing—allowing professional investors to actively approach third-country funds/managers—and also extend the passport to non-EU funds/managers if they passed certain qualitative criteria. National private placement regimes could remain in place during a transition period with the arrangements being subject to future review. However, this is only one possible outcome; it has not yet been agreed by the parties.

The aim was for a vote in a plenary session of the parliament during the week commencing 20 September, but this now looks unlikely, and it would appear the process is set to continue into October.

EU lawmakers had promised a vote on the final version of the AIFM directive—one reconciling the council and parliament versions of the text—by early July, from AIMA’s perspective, is this delay a good thing?

Yes, well, I think so, I think the longer that it’s considered and the nonsenses that are still in there get ironed out, the better it is….My answer is based around the progress that’s been made through the trialogues [discussions between representatives of the European Commission, the EU Parliament and EU Council of Ministers] which has been very painfully slow.

What are AIMA’s biggest concerns about the proposed rules?

Our [two] favorite topics, really, are the third-country issues followed fairly smartly by issues around depositories… there’s another sub-list underneath, but those seem to be the two which have been postponed in terms of serious discussion because they are the more difficult items.

There are still serious gaps between the council versions and the parliamentary versions and until that gap is closed by compromise, those items will still remain outstanding. And I think we’re just very keen to make sure that some sort of national discretion in terms of private placement regimes is preserved, absent greater clarity on what a passport is going to look like, because the whole question of eligibility criteria and the topic of regulatory equivalence is so fraught with difficulty. The idea of introducing a passport which works smoothly within and without the EU is, I think, fanciful. So, the only mechanism we’ve got, absent a complete lockout or investment ban, would be a maintenance of the status quo, which would be the national private placement regimes.

What are your concerns about the proposed new rules for depositories?

The depository issue can actually be summarized fairly quickly—there are two underlying points. There’s one about liability and there’s another one about choice. We’re very keen to make sure that a model is adopted which allows something resembling the existing structure for our industry and for the other alternative investment management sectors to continue to be able to operate, because modern custodial activities and prime broking activities require the ability to delegate to other parties in order to have a global custodial network or sub-custody network, and obviously you want to maximize choice of the organizations capable of offering such services. You don’t want to have a restricted diet of EU-sanctioned entities. And so, there are questions remaining about what liability anyone taking the role of custodian should be subject to in the event of material losses to underlying investors within funds. And at the moment, we’re still locked into the concept of strict liability as opposed to what we would call a sort of normal level of commercial liability, which revolves around gross negligence or failure to perform your duties. That debate has still has not been resolved. There is still a philosophical difference about whether all investment losses, however derived, should be the responsibility of the depository, or whether they should be restricted only to those where the depository has been grossly negligent.

What is the worst-case scenario, from AIMA’s perspective? Do you think this legislation could have a serious impact on the industry?

Oh, it could be immense, because if EU investors are denied access to the world’s best managers across a wide variety of expertise, then are they going to be forced to disinvest? Is it going to put on hold capital movements? There are potentially severe impacts for the smooth working of the investment management providers, and also the ability of investors to manage their asset and liability structures sufficiently. That’s the real nightmare scenario and obviously we’re hoping the trialogue process will come up with a series of compromises which avert that danger.

The European Parliament recently passed remuneration rules requiring financial institutions to ensure there is an "appropriate" balance between fixed salaries and bonus payments – bonuses will not be able to exceed 50% of an individual’s total pay; companies will have to defer at least 40% of bonus payments for a period of at least three years; cash bonuses will be capped at 30% of the total bonus. What is AIMA’s take on this?

Well, this is quite a complex topic because there are two directives which cover remuneration provisions. The one that’s been in the press recently is what we call the banking directive, which is the CRD (the capital requirements directive), and that has come out with a general statement saying that anyone who is an investment firm, whether that’s an investment bank or a broker dealer or an investment manager with a MiFID [Markets in Financial Instruments Directive] authorization will be covered by the general principles of the restrictions on banks which were passed this week. Now, obviously there’s going to be a huge overlap between the language that’s in the CRD, which has been passed, and the language on remuneration in the AIFMD, which has not yet been passed. And I think we’re just keen to ensure there’s a level playing field between those two directives. A lot of hedge fund managers, particularly in [the UK] will be MiFID firms and therefore they will be covered already under the CRD and the CRD has introduced this concept of proportionality [i.e. the idea that it might not be appropriate to apply all the rules to small credit institutions and investment companies]. We need to understand what this proportionality looks like but it appears to offer the principle of proportionality in the application of these measures to national regulators, and we think that’s important.

Come October, are you optimistic the final version of the text will be one your industry can live with?

I think that the signs are promising that commonsense will prevail. It’s taken a little while for the real nature of the arguments or the real positions to emerge but I think that there is proper debate around the trade-off between introducing pan-European legislation in an area which previously had none and making sure no damage is caused because the existing structure of the industry defies an easy, one-size-fits-all solution. So, I’m confident now that the trialogue process has identified the areas of main difficulty and serious attention is being devoted to getting these compromises resolved...I might be a slightly lonely voice on this but I am fairly optimistic that we’re going to have an outcome that we can all live with.

Editor's Note

In our new section, FINtech Focus, we will profile one of these firms each week. While fintech is a broad category, we will be focusing on firms that specifically cater to the alternative investment industry. Read more…